Friday, December 28, 2007

Payday Lenders, Part Two

While researching the previous article I called a friend who makes a living as a banker. During our conversation I described the type of transaction I used as an example in the other article. You remember my 15% loan to my friend Charlie. My banker friend immediately saw it as a 390% loan. (Actually Barnie, it's 391.07%. I guess engineers are more precise than bankers.)

Bankers are funny critters. I suppose I'll never fully understand how Annual Percentage Rate is calculated. No, that's not quite right. I do understand how Annual Percentage Rate is calculated; I just don't understand why it is always used to describe a short-term loan that, by law, must be re-paid in 30 days or less. But apparently they teach you to think only in annual terms at that big banker school in Carolina.

Now, if Charlie came to me next Friday and explained that his cash flow was still weak and that he would have to pay me the 15% interest and hold off for a while on the rest, that would be getting closer to my banker friend's 390% interest rate, but it's not there yet. Charlie would have to repeat that performance every two weeks for a year before he hit that magical APR number. (While I may enjoy that $7.50 a week in extra income, at some point I'm going get sentimental about that original Franklin portrait and want to see it again.)

As I said, that can't happen legally. What Charlie can do, and some folks resort to I suppose, is pay me the full $115 and immediately ask for another loan at the same terms. Charlie and I both know this is a dumb move, but Charlie is desperate, and I'm a sucker for a quick and easy $15 bucks, so we strike a deal. I can't say that rollovers of that sort do not occur frequently across the Commonwealth, but the folks I've spoken to in this area who work at payday lenders tell me that none of the lenders in Henry County will continue to approve such loans. Further, most of the payday lenders in Henry County use a private statewide (or maybe it's national, I didn't ask) database that will inform them if a potential customer has outstanding payday loans at other lenders, this helps prevent Charlie from getting a loan from Joe to repay me.

I suppose that Annual Percentage Rate is used so as to always be comparing apples to apples when discussing the merits and disadvantages of various lending practices. So be it. It may also be used merely as a way of making payday loans look much worse than they really are. Either way, let's compare apples to apples.

What were Charlie's options last week when his electric service was about to be cut off? He could have written a bad check to APCO, hoping that either it would not clear until his next payday, or more likely, it would be after his next payday before APCO made him aware of the bounced check. By then though, he would have the cash to go to APCO and pick up the check, even though it would cost him at least a $25 returned check fee, plus the fee from his bank, at least another $25. So now Charlie is paying $50 in "interest" on this "backdoor loan", at an Annual Percentage Rate of 1,304%. But wait, Charlie's APCO bill was already late, that's why he got the disconnect notice, remember? So APCO put a $35 "late fee" onto his $100 bill, an APR of 426% (since the APCO bill is payable monthly I calculated the $35 at a 30 day term, resulting in a proportionally lower APR).

Charlie's other option was to simply live in the dark for a week. That would leave him with the original $100 bill, plus the $35 late fee, plus a $25 reconnect fee, at an APR of 730%. That doesn't include the cost of replacing all of the food in his freezer, or the cost of many dinners and flowers to get his wife to speak to him again.

That $15 bucks Charlie paid me is beginning to look like a real bargain, no?

People have always gotten into trouble with debt. People will continue to get into trouble with debt, even if the payday lenders are closed. The fact is, for the vast majority of their customers, payday lenders provide a valuable service. As long as they are used in the manner they were intended, they are a valuable resource to a community. Used as a long term solution to poor financial planning, they are a catastrophe, but still better than most of the alternatives.

The final question is, is it the proper role of government to protect us from our own stupidity? Or even worse, the stupidity of others? I don't think so.

NOTE: In fairness to my banker friend, he and I essentially agree on this subject.

Next: Why short-term, low dollar loans are not available at your friendly local bank anymore.